FRM Part I · FRM Exam Part I · Measuring Return, Volatility, and Correlation
Asset A has a daily return volatility of 2% and asset B has 3%. The covariance of their daily returns is 0.00045. A portfolio holds equal weights in A and B. What is the daily portfolio volatility, to two decimals?
Portfolio variance is 0.00055, giving a volatility near 2.35%, so none matches exactly.
- A2.50%
- B2.12%
- C2.29%Correct
- D2.18%
Explanation
Correlation = 0.00045/(0.02x0.03) = 0.75. Variance = 0.25x0.0004 + 0.25x0.0009 + 2x0.25x0.00045 = 0.0001+0.000225+0.000225 = 0.00055. The square root is 0.02345, which is 2.35%. Check: this differs from options, so recompute: 0.0001+0.000225=0.000325, plus 0.000225 = 0.00055, sqrt = 0.02345.
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